“That is the story of this country…the story of generations of people who felt the lash of bondage, the shame of servitude, the sting of segregation, but who kept on striving…so that today I wake up every morning in a house that was built by slaves…and I watch my daughters…two beautiful intelligent black young women playing with their dogs on the White House lawn. So, look, don’t let anyone tell you that this country isn’t great, that somehow we need to make it great again. Because this right now is the greatest country on earth!” First Lady Michelle Obama. Democratic National Convention. July 25, 2016.
A few anecdotes of recent meetings in which I have participated, in our offices and in plants and business facilities around the United States, support Mrs. Obama’s opinion. Because America provides freedoms and opportunities unavailable elsewhere, America attracts gifted, hardworking individuals, most of whom, with their families, have taken great risks to emigrate to our nation. We think our lives and country can improve, but they are already remarkable in comparison to anywhere else. We believe the personal stories, values and successes of our fellow Americans, both natural born and immigrants, with whom I meet daily and whom I think are so fascinating, are what makes our nation’s future so promising. I am certain if you could be an impartial observer in the thousands of meetings and conversations with company managements and our clients that we conduct annually, you would reach the same conclusion.
Marc Spilker was formerly the head of Goldman Sachs Investment Management Division. He had also served as President of Apollo Global Management. Marc is my friend. Marc, with eighteen other individuals, recently started an investment management company that focuses on unconstrained asset allocation among various world geographies and asset classes. Earlier this year, Marc asked if I would have lunch with him and his partner, Enrico Gaglioti, to talk about challenges and opportunities for investment management businesses. Enrico had been Goldman Sachs’ Global Head of Equity Sales. When I asked Enrico about his background and how he had become so successful, he told me that his father had emigrated to America in 1955 from a small town in southern Italy and became a construction worker. Thirty years ago, Enrico was 14 and wanted to spend his summer at a soccer camp. Since Enrico hadn’t done very well in school that year, his dad suggested that Enrico instead work as his apprentice for the summer. Enrico’s pay was $7 per hour, a lot for a young man at that time. Enrico, a pretty big guy now and probably not so small then either, spent the summer digging ditches and carrying 60 pound cinder blocks which, despite gloves, made his hands bleed every day and him collapse on his bed every evening. At the end of that summer, Enrico’s dad gave his son two choices. His dad’s choice, Enrico told me, was that Enrico drop out of school and work as his apprentice. His dad’s second choice, was that Enrico could work really hard in school and get exceptional grades to earn a college scholarship. Otherwise his dad could not afford to pay for his college. “I am going to stay in school and will work hard to get good grades to earn a scholarship,” Enrico responded. Which he did. Several years ago, Enrico brought his wife and children to that small village of 800 in the foothills of southern Italy where his relatives still lived. When his wife saw Enrico’s dad’s home, her eyes filled with tears. She was overwhelmed by the idea of his dad coming to America where he didn’t speak the language; with no money; leaving his parents; and the sacrifices he must have made for the family he would someday have.
Baron Funds has been an investor in the innovative, gene sequencing company Illumina, Inc. (NASDAQ:ILMN
) since 2011. Illumina’s share price has since increased nearly five-fold. We had believed Illumina could increase several fold again within the next decade. Jay Flatley, the company’s CEO, had led Illumina since 1999 when its annual revenues were $1.3 million. Illumina’s revenues last year were $2.2 billion. Jay visited us earlier this year with Francis deSouza to tell us he was going to retire as CEO and become the firm’s Executive Chairman. When he told us that Francis would become the firm’s CEO, we were initially surprised and concerned.
After speaking with Francis for a couple of hours, however, our concerns lessened. Francis had been recruited by Illumina three years ago when no one in life sciences fit the mold Jay sought for his successor. Francis was born in Ethiopia. His family belonged to the lower middle class in that country. When his father, who didn’t finish high school, lost his job, his dad moved his family to Dubai. Francis was then 13. In Dubai, Francis wrote software as a child to help his family. By coincidence, one of Francis’ teachers in Dubai was our technology analyst Ashim Mehra’s mom. Ashim’s mom considered Francis one of the two brightest students she ever taught! As a result, Ashim has known Francis for more than 30 years! When Francis was 16, he decided to attend college in America. He applied to MIT and Stanford and was accepted by both. When he told his parents, they were initially disappointed! This was because they thought talented children in Dubai should attend school to learn to fix air conditioners! Francis raised money for airfare, food and housing and was selected for an IBM scholarship at MIT. After graduating college, Francis became a principal building and selling two businesses, one for $20 million to Microsoft, a second to Symantec for $90 million. When he left Symantec, his firm had over 15,000 employees. I suppose you can begin to understand why our concerns about management succession at Illumina dissipated after our meeting. I suppose you can also understand why I am so optimistic about our country’s prospects when America attracts immigrants like Francis. One more thing. Francis brought his parents to America and bought them a home that was much different than the one in which he grew up.
Jamie Stone, Baron Energy and Resources Fund’s portfolio manager, had interviewed research analyst candidates for more than a year to work with him. In 2014, Jamie introduced us to Chingiz Gadimov, who joined us soon afterwards. Chingiz was born in the Republic of Azerbaijan, and was six when his country gained its independence after the collapse of the Soviet Union in 1991. Azerbaijan is at the crossroads of Central Asia; the Middle East; Southeastern Europe; the Caspian Sea; Russia; Georgia; Armenia; and, rounding out Chingiz’ quiet and serene (only kidding) neighborhood, Iran.
Chingiz graduated from college in Azerbaijan in 2005 and from Harvard Business School in 2011. After college, Chingiz worked for BP in his country for four years. Chingiz’ business unit focused on the development of some of BP’s largest oil and natural gas projects in the world. His work included strategic planning, financial modeling and valuation of major projects, as well as supporting senior executives with regional energy market analysis. After he graduated from HBS, Chingiz worked as a Senior Equity Research Associate at Citicorp. Chingiz’ mother is a physician. His dad has a degree in applied mathematics. We assume there are not many individuals like Chingiz who were courageous enough to leave Azerbaijan to come to America, and who are smart and accomplished enough to gain admission to Harvard Business School. When I asked Chingiz how he came to America and was accepted to Harvard, he told me that his parents had owned a small country house near the sea that he visited a lot as a child during summers. His parents sold that property in 2000 to pay for Chingiz’ tutors, enabling him to gain admittance to the best college in Azerbaijan and to ultimately come to the United States. “You’re hired!” I told Chingiz after telling us his “story.” We thought his parents’ values made his exceptional qualifications irresistible.
“Things are worth what other people are willing to pay for them…Who cares if I overpaid by 5%?” Steve Ballmer. Owner. LA Clippers. 2016.
That was Steve Ballmer’s retort when he was critiqued for paying $2 billion two years ago to purchase the LA Clippers basketball team…a franchise that is already worth more than Ballmer paid! We believe, as Ballmer apparently does, that if you plan to purchase and own a unique and valuable media asset with favorable long-term growth prospects like the Clippers, a purchase price that is a small premium to present “value” is immaterial.
Ballmer’s remark reminded me of a conversation I had with one of our country’s leading art dealers when he recently had lunch in our office. “Would $250 million be enough to get started?” was the question he was asked about fifteen years ago by an individual seeking to build an art collection for his business. The dealer advised purchase of “museum quality art, the best examples of the best artists, art blue chips, by the movers in art history.” The dealer also stated that to purchase such pictures the buyer would need to pay modest premiums, 10-15%, over the immediate resale value of those pictures. This was since there needed to be incentives for dealers to locate such pictures. This dealer ultimately found, and his client purchased for his business, pictures by Picasso, Van Gogh, Monet, Manet, Mondrian, Jackson Pollock, Lichtenstein and Jasper Johns of the “highest quality.”
Despite “overpaying” when the business executive first bought those pieces, the dealer’s parting comment after our lunch was, “I’ve made him so much money.”
It took time for the value of the L.A. Clippers to exceed Ballmer’s cost. It also took time for the appreciation of “museum quality” art the businessman acquired to exceed its cost. Which is similar to Baron Funds’ very profitable long-term investments like Vail Resorts, Inc., CoStar Group, Inc., Gartner, Inc., Under Armour, Inc., Arch Capital Group Ltd. and so many others. Many of our new investments may be modestly overpriced relative to their present fundamentals at the time of our initial investment. It often takes some time for the fundamentals of our newly purchased growth businesses to catch up to and exceed their present valuations…and continue to grow much faster than the economy and stock market. If the growing businesses and talented executives we have identified through our proprietary research and in whom we have invested continue to grow as we expect, those businesses will become significantly undervalued before long and provide significant long-term capital appreciation. Just like the top 15 investments listed in Table II have done. Of course, we cannot assure you that our future investments will be as successful as the investments we have listed.
Baron Funds’ long-term investment strategy that often takes several years to achieve significant gains is a lot different than the months, quarters, weeks, days, seconds or nano seconds that measure the time periods short-term traders employ attempting to achieve lots of smaller gains. In Tables I and II you can see the absolute and relative successes of our proprietary research and long-term investment process. At present we estimate about 30% of our mutual fund investments are what we consider to be in “incubator investment phase.” Benefitfocus, Inc. is penalizing its current profits by investing heavily to add new customers. Manchester United plc’s revenue from media and licensing fees is being repriced substantially higher. Tesla Motors, Inc. is investing heavily to build the infrastructure it needs to profitably meet the demand it has created for what we regard as the safest and most innovative cars ever built. Iridium Communications Inc. is about to launch a new constellation of communications satellites that is critically important to America’s Department of Defense as well as to the “Internet of Things.”
Albert Einstein called “The power of compound interest the most powerful force in the universe.” We hope you will agree that the compound rates of returns earned by the Baronmutual funds listed below have been outstanding on both an absolute and relative basis since their inceptions.
“I’m going to Detroit tomorrow. I have a great idea for a Cadillac with an interior by Polo.” Ralph Lauren. Executive Chairman and CEO. Polo Ralph Lauren Corp. 1997.
When Polo Ralph Lauren Corp. became publicly owned on June 11, 1997, we began to research that business. Late that summer, we called Ralph Lauren, the firm’s CEO. We then spoke about the potential profitability of Polo’s factory outlets; its innovative, department store “shops in shops;” and, potential conflicts between Polo’s full priced stores, its factory outlets, and its “wholesale” department store customers. Before ending the call, I asked Ralph about his plans for the weekend. He told us that, before leaving for the beach, he was going to Detroit. He intended to propose to General Motors a Cadillac model with an interior by Polo. Curious about that meeting, I called after the weekend to ask how it went. “Not well,” was his response. Cadillac’s executives thought Ralph’s idea was a good one, but Cadillac had already designed its product line for each of the next seven years! Before Ralph returned to New York, the car company’s executives walked him through their design studio to show him those models. “You and I would buy those cars today if they were in production,” Ralph told me.
We think this story illustrates why incumbents are often unsuccessful competing against innovative and disruptive challengers. In our opinion, it is because established profitable businesses invest to grow steadily, create cash flow to pay dividends and return capital to their shareholders. Their managements are not financially incented to quickly grasp and invest in risky new concepts and methodologies that have the potential to obsolete their existing businesses…until it is too late.
This is whether it is newspapers and cable television businesses imperiled by the Internet; land line telephone companies imperiled by cellular; book stores and department stores imperiled by Amazon; door to door encyclopedia sales imperiled by Google; “active” mutual fund managers and hedge funds imperiled by ETFs and passive funds that perform a little worse than the market…consistently; monopoly taxi companies imperiled by Uber; and computer software imperiled by software as a service. The culture of incumbents is not to look around corners and imagine an idea that seems unlikely or impossible to succeed. Like electric cars or autonomous driving or reducing the time to market for new car models from years to months…and producing several times the quantities of automobiles in factories that car plants have ever produced by “densifying” manufacturing facilities.
We also think it unlikely that a senior executive in a business being disrupted would move his desk to a plant production floor like Elon Musk had done and spend his nights in a sleeping bag until his factory could produce cars with gull wing doors that work flawlessly. That effort has been met by investor skepticism and questions about whether Tesla can deliver as many Model 3s next year as the company believes possible. Not whether this business can become the largest car company in the world with the highest gross margins as a “capital light” business over the next ten to fifteen years! Despite the fact that Tesla is operated by an individual so talented he builds rocket ships through his SpaceX company, with Boeing, for America’s space program that had previously been managed by NASA!
25th Annual Baron Investment Conference. November 4, 2016. Metropolitan Opera House. Lincoln Center. New York City.
We hope you will be able to attend our 25th annual investment conference on November 4th. The meetings have grown from fewer than 35 attendees at our first meeting in 1992 at New York City’s Harmonie Club to more than 5,000 at New York City’s Met last year. Our meetings are intended to allow you to meet and question executives of businesses in which Baron Funds has invested. We will again have some pretty special speakers this year…whom we think you will be pleased are managing businesses in which your savings have been invested! We also intend for these meetings to give you an opportunity to meet and question Baron portfolio managers and analysts, our client services representatives, Linda and me. We are there to discuss our investments, process and any other topics on your mind…no questions are off limits…all day long. Finally, the entertainment at lunch and at the end of the day as usual, will be incredibly cool. Also, as usual, it will be at our expense, not yours. And, as usual, it will be a surprise.
We hope we will see you at The Met on November 4th. For those of you who can’t attend, though, you will be able to watch our meeting streamed live on the Baron Funds website…everything but the entertainment, that is (we are contractually prevented from streaming entertainment). You can get a sense of our meeting by watching CNBC’s Squawk Box that morning from 6 AM to 8:30 AM (Eastern Standard Time). Becky Quick will first interview me and then the two of us will interview several executives with whom we have invested and with whom we expect Baron Funds to make a lot more money…although we obviously can’t promise that.
We like to say that “we invest in people.” When you attend our annual conferences or watch us on CNBC or visit us at our website, we believe you will gain a better understanding of the businesses in which we have invested; of the individuals who lead those businesses; and of the character and talent of the individuals with whom I work. In the end, we think it’s all about people. It is why I expect to never stop “working.”
“How does a ragtag volunteer army in need of a shower…somehow defeat a global superpower?” Hamilton. Broadway smash hit. 2015.
A good friend called me last week to discuss the 2016 Presidential election campaign. He then relayed the advice Abigail Adams gave to her husband John Adams in 1775. This was when the future second president of the United States despaired over the state of the “ragtag” Continental Army; the new country’s chances to achieve independence from Great Britain; and its untested and newly appointed general, George Washington. After meeting Washington, Abigail Adams wrote to her husband, “I was struck withGeneral Washington. He has a dignity with ease…the gentleman and soldier look agreeably blended in him. His appointment was received with universal satisfaction and he offers hope.”
Don’t forget to vote and don’t lose hope in America.
Thank you again for joining us as fellow shareholders in Baron Funds.
We will continue to work hard to justify your confidence in us.
See you in November.
CEO and Chief Investment Officer
July 27, 2016 More...